An Options-Centric View of Apple Earnings

by Tyler Craig | January 22, 2013 8:31 am

The long-awaited Q4 earnings release from tech giant Apple (NASDAQ:AAPL[1]) is slated for Wednesday afternoon. Since reaching an all-time high of $705.07 late last year, shares of AAPL have fallen nearly 30% — a full two-thirds of that occurred after AAPL’s Q3 announcement in October 2012.

AAPLpricechart 300x173 An Options Centric View of Apple Earnings
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From a technical view, the momentum darling of yore remains under pressure as the stock price sits firmly in a downtrend beneath declining 20-, 50-, and 200-day moving averages.

The $64,000 question tickling the minds of AAPL-watchers is whether the stock’s pathetic performance of late is justified. Will the recent spate of weakness turn out to be an epic buying opportunity … or the beginning of a transition where AAPL morphs from a magical growth stock to something far less promising? No doubt, Wednesday’s earnings release will provide more clues for the sleuths among us.

Let’s take a peek into the options mart to see what type of volatility expectations that derivative players are baking into option prices.

The easiest way to assess the magnitude of the earnings reaction expected by the Street is to view the price of a straddle using weekly options.

Currently, the Jan 500 straddle — long Jan 500 call + long Jan 500 put — is trading for $35.80. The expectation, then, is that AAPL will rise or fall 7.16% ($35.80/$500) by the end of the week. If you think AAPL is poised to move more than expected, consider buying volatility in some fashion ahead of the number. On the other hand, if you think AAPL does not move plus or minus 7.16%, consider selling volatility.

We’ll look at two such short volatility plays a bit later.

AAPLIVchart 300x233 An Options Centric View of Apple Earnings
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For historical perspective, I’ve included the following chart of 30-day implied volatility (IV) for AAPL options. At 41%, IV sits at the upper end of its range and at the second-highest pre-earnings level for the past two years. For those interested, the award for highest pre-earnings IV belongs to the Q1 (April) earnings of 2012 when IV reached 45%.

In light of the evidence, here are a couple option plays worth consideration:

Iron Condor

Traders lacking a directional bias who agree that volatility is worth selling at current levels could enter a March iron condor by selling the March 410-400 put spread and the March 600-610 call spread for a net credit of $1.50 or better. Provided AAPL moves less than expected over the next few weeks, the trade will yield a profit.

If you ride the position all the way to March expiration, the max reward is limited to $150 and will be captured if AAPL remains between $410 and $600. The max risk is $850 and will be incurred if AAPL rises above $610 or falls below $400 by expiration.

Bull Put Spread

If you believe AAPL is more likely to jump higher after earnings — or at least not fall as much as anticipated, you could sell a Feb 430-420 bull put spread for $1.00 or better. The max reward is limited to the initial $100 credit and will be captured if AAPL remains above $430 by Feb expiration. The max risk is $900, but can be reduced if you exit early — such as if AAPL falls below the short put strike price of $430.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.

  1. AAPL:

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